Difference Between debt and equity Financing
Debt financing refers to any borrowed money which theentrepreneur must pay back to the lending institution. It can come in the form of a loan, line of credit, bond, or even an IOU. An interest rate and other terms apply.
Equity financing is money lent in exchange for ownership in a company.New businesses can use equity financing for their startups or when they need to raise additional equity capital to offset existing debt. Who depends on this type of capital?
• Companies which are well- established and have demonstrated steady sales, solid collateral, and profitable growth often rely on debt capital for financing their businesses.
• Companies with a more conventional approach to management, high profitability, and/or poor credit ratings often rely on equity capital for their funding needs. • Ideal form of capital for small businessstartups and newly launched companies since they have not established a solid track record of success and face uncertainty in their early stages of development. Where can I obtain this type of funding?
• Commercial banks • Loans through the Small Business Administration (SBA)
• Personal funds (bootstrap finances) can be obtained from savings, credit cards, retirement accounts, property equity, etc. • Friends and family can lend money for a stake in the company. • Angel investors and venture capitalists can also provide a new business owner with desired capital in exchange for a board seat, a stake in the company, and large return on investment. • Investment banking firms
• Insurance companies
• Large corporations
• Government-backed Small Business Investment Corporations (SBICs) Debt-to-equity ratio
High (ideally, 1:2 or 1:1, depends on industry)
• Exceptional credit history of borrower.
• Borrowers must show potential lenders they are willing to invest money in the business by using their own money.
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